Japan Renewables Alert 60

7 minute read


Today’s Topic

Corporate PPAs (No. 3) – Application of Commodity Derivatives Transaction Act to Virtual PPAs

On November 11, 2022, it was announced on the website of Japan’s Cabinet Office that the Commodity Market Development Office (Commerce and Information Policy Bureau, Commerce & Services Group, Commodity Market Development Office) of the Ministry of Economy, Trade and Industry (METI) has expressed their stance that the Commodity Derivatives Transaction Act (the CDTA) does not apply to the settlement of differences in virtual PPAs as long as certain conditions are satisfied (see here; specifically, No. 7; only in Japanese). The announcement of the stance was made in response to our request we submitted via the Cabinet Office to the Commodity Market Development Office, which oversees electricity futures trading. Now that an official position of the Commodity Market Development Office has been published with respect to a major obstacle to a virtual PPA scheme, there is the possibility to further accelerate the realization of virtual PPA transactions in Japan.

1. CfD Settlement in Virtual PPAs

A virtual PPA generally refers to a transaction between a renewable energy power producer and a corporate customer in which renewable energy certificates are traded without any actual power transactions. In Japan’s context, it usually refers to a transaction in which a consumer purchases non-FIT non-fossil certificate (NFCs) from a renewable energy power producer with renewable designation equivalent to the amount of electricity generated at a specific renewable energy power plant.

In Japan, since only registered electricity retailers (or permitted and registered specific transmission and distribution companies) are allowed in principle to sell electricity to consumers through the grid, renewable energy power producers without such registration cannot trade electricity itself without going through an electricity retailer. On the other hand, direct transactions of non-FIT NFCs (with renewable designation) from renewable power producers to corporate customers have become possible since April 2022 for non-FIT renewable power sources that meet certain requirements. Reforms to allow such direct transactions were made to address the high level of consumer interest in virtual PPAs, which allow for the exclusive procurement of renewable energy certificates from specific renewable energy power plants without having to change existing electricity retailors. Tracking procedures have been expanded to cover such direct transactions, as announced in October 2022 (see here and here for related materials on the website of BIPROGY Inc., which was commissioned by METI and JEPX for the NFC verification and the tracking services).

In virtual PPAs conducted in the United States and other countries, it is common to use contract for difference (CfD) based on electricity market prices. Specifically, the difference between the electricity market price (in Japan, the price per kWh in the day-ahead JEPX price for the area where the power plant is located) and the pre-agreed contract price per kWh is multiplied by the amount of electricity generated during the relevant time period (30-minute timeframe), then aggregated for a month, for example, to calculate the value for settlement. During the timeframe when the market price is lower than the contract price, the consumer pays the power producer for the difference, and during the hours when the market price is higher than the contract price, the power producer pays the consumer.

2. Previous Interpretations and Orrick’s Inquiry

With regard to CfD settlements based on electricity market prices, it had been suggested that, in principle, permission from the Minister of Economy, Trade and Industry could be required pursuant to the CDTA. Electricity constitutes a “commodity” under the Commodity Derivatives Transaction Act (CDTA) (art. 2, para. 1, item (5)), and it is considered that CfD settlements referring to electricity market prices could constitute an “OTC commodity derivatives transaction” under the CDTA (art. 2, para. 14, item (2)). Conducting OTC commodity derivatives transactions as business, in principle, constitutes a “commodity futures transaction” (CDTA, art. 2, para. 22, item (5)) and thus requires permission from the Minister of Economy, Trade and Industry (Article 190, paragraph 1).

We mentioned such potential risks to certain developers in discussing the possibility of virtual PPAs in Japan in 2019, and made inquiries to the Commodity Market Development Office around November and December of 2020 and thereafter until early this year, but the continual response was that CfD settlements would constitute an OTC commodity derivatives transaction. Permits for commodity futures business are generally obtained by banks and securities firms specializing in financial services (see here for a list of permitted commodity futures business operators), and renewable energy power producers and operators wishing to conduct virtual PPAs have had to face considerable hurdles in obtaining them. Likewise, OTC commodity derivatives transactions that meet certain requirements are not considered to be commodity futures transactions even when conducted as a business, such as the counterparty being a stock company (KK) with the capital of at least 1 billion yen, are very steep and present a major hurdle to structuring virtual PPA transactions in practice (CDTA, art. 2, paras. 22 and 15; Enforcement Rule for CDTA, art. 1; note that conducting such exceptional OTC commodity derivatives transactions as a business requires filing of a notice as a “specified OTC commodity derivatives transaction business” under the CDTA, art. 349, para. 1).

We therefore compiled and submitted a request to the Cabinet Office to be reviewed by its Task Force for Review of Regulations Concerning Renewable Energy (再生可能エネルギー等に関する規制等の総点検タスクフォース), which is charged with work on regulatory reform in areas related to renewable energy, with our request being forwarded to the Commodity Market Development Office through the Cabinet Office. After meeting with us, the Commodity Market Development Office submitted to the Cabinet Office a written statement of its stance on applicability of the CDTA to CfD settlements under a virtual PPA scheme, which was published on the Cabinet Office’s Web site on November 11, 2022 (see item no. 7 in the link above).

3. Interpretation of the Commodity Market Development Office

The Commodity Market Development Office announced that, “generally speaking, the CDTA does not apply to CfD settlements if at least the following items can be confirmed in the relevant contract and such contract as a whole can be deemed to be a purchase and sale of renewable certificates, etc.” where the “following items” are (1) “that the traded environmental attributes are actual (not self-called eco-points, etc.)” and (2) “that the transfer of rights to the environmental attributes from power producer to consumer can be confirmed.”

“Actual” in item (1) refers to environmental attributes that are widely recognized for trading, and, in response to our inquiry, the Commodity Market Development Office stated that non-FIT NFCs under the current system satisfy such requirement. Transactions involving “self-called eco-points” that are not widely recognized are excluded because they leave room for interpretation of such transactions being electricity derivatives transactions under the guise of sale and purchase of environmental attributes.

“Transfer of rights” under item (2) refers to making clear that the contemplated transaction be a sale and purchase through the delivery of renewable energy certificates representing environmental attributes from seller to buyer. It is possible, for example, that a transfer of rights would not be recognized if renewable energy certificates are treated as having been transferred to the consumer but are in fact kept with the power producer.

Because the reason for the above interpretation is that the transaction as a whole can be understood as a sale and purchase of environmental attributes, and not an electricity derivatives transaction, the transaction could, again, be seen as an electricity derivatives transaction under the guise of sale and purchase of environmental attributes if the contract price per kWh is set at 1,000 yen or some other price level that deviates significantly from market trends.

4. Future Outlook

Non-FIT corporate PPAs are expected to become one of major schemes of renewable transaction in Japan. As we have been involved in multiple corporate PPAs in Japan so far, we believe that such trend will be further accelerated by the publication of the interpretation of the CDTA by the authority.